Unintended Consequences of Obama’s Tax Cuts
Policy + Politics

Unintended Consequences of Obama’s Tax Cuts

There’s little debate over whether the tax hikes the President proposed as part of his State of the Union address would achieve his main goals – raising revenue to fund middle class tax breaks.

The real question is what unintended consequences would emerge. Truth is, while White House tax proposals are intended to hit only the very wealthy, they are likely to ding many people who are also middle class.

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Tax policy experts disagree as to how severe the knock-on effects would be. Many fiscal conservatives have raised concerns about higher taxes leading to slower economic growth and impeding entrepreneurial activity.

Other tax experts say the proposals are so straightforward that there wouldn’t be significant broader consequences. “There are always indirect effects,” says Martin Sullivan, chief economist at research firm Tax Analysts. “But in this case they are very uncertain and likely to be very small. “

Here’s a closer look at some unintended consequences if the President’s tax hikes become reality:

Many retirees would see their real incomes fall. The White House plan raises the top capital gains and dividend tax rates for high-income households to 28 percent from about 25 percent. This sounds like a pretty small increase, but it’s just the latest in a string of capital gains increases in recent years that has almost doubled capital gains taxes, which were 15 percent as recently as 2012.

This rate applies to couples with incomes over about $500,000, a hefty sum. But for couples that saved throughout their careers and then get to a phase when they need to start selling chunks of stock to fund their retirement, this hike would be one more reason their savings amounted to less than they forecast.

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It would be harder for families to hold onto appreciated assets or property for generations. The White House proposes eliminating the “trust fund loophole” which allows people to pay no tax on inherited assets. The President’s proposal would close the loophole, treating death as a taxable event.

The administration argues that it’s mostly wealthy people who can afford to hold onto assets until death since most middle class people need to spend down their assets during retirement. For families that can afford to hold onto assets, current tax policy “creates strong ‘lock-in’ incentives to hold assets for generations,” White House points out in its fact sheet on the proposed changes.

The corollary to this is that by eliminating the loophole, many heirs may well have to sell inherited assets to fund the capital gains tax bill. To minimize the impact on charities, family businesses, real estate and personal property, the White House has proposed a long list of exclusions.

Many families would face a record-keeping nightmare. William Gale, a tax policy expert at Brookings, raised this concern in a recent blog post, even as he applauded the President’s capital gains proposals. If assets held until the owner’s death are taxed, people would have to reconstruct records from years ago, resulting in “large and sometimes impossible record-keeping burdens,” he notes.

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He proposes the White House include a “standard basis” similar to the standard deduction, so taxpayers who don’t want to come up with proof of the original cost basis have an alternative.

Banking could get more expensive and difficult. The White House proposes adding a fee on large, highly-leveraged banks. Not only would the new tax raise revenue, but it would discourage banks from borrowing so much.

Some banking analysts believe the banks would just pass the new fee onto customers. “Although banks would themselves be directly assessed the fee, much if not all of the rising cost would be passed onto the average American in the form of costlier transactions,” writes Sterne Agee chief economist Lindsey Piegza.

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Another potential consequence of this proposal is that it could make it tougher for consumers to borrow if banks restrict their own borrowing activity to avoid the tax. That could impact home-buying activity, says Clifford Rossi, a professor at University of Maryland’s business school.

Sullivan, for one, is skeptical the new tax would have much impact on consumer banking. “Banks are so profitable they can just absorb this hit,” he believes.

It’s easy to dismiss many of President Obama’s proposals because partisan politics make them unlikely to pass this year. But that doesn’t mean that they won’t see the light of day at some point in the future.

It is early days yet, but as broader tax reform moves to the front burner, it’s worth thinking about potential unintended consequences of the President’s latest proposals now.

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